Finding Alpha: The Search for Alpha When Risk and Return Break Down
"Eric Falkenstein is more than one of the smartest and funniest
people in finance. He's been a banker, a key model builder at a
major rating agency, and a hedge fund trader. In this tour de
force, he outlines the successes and failures of financial theory
applications in the real world from the perspective of an
aggressive early adopter of the best ideas in finance. To this day,
I think Eric's private firm default model is one of the best papers
ever published in applied finance, and this wonderful book falls
into the same category."
—Donald R. van Deventer, PhD, founder and Chief Executive Officer, Kamakura Corporation
"People dismissed Columbus when he said the world was round.
Thank goodness he persisted. Like Columbus, Falkenstein challenges
standard thinking, only this time about risk and reward. As the
meltdown of the capital markets has shown, the financial industry
clearly missed something with regard to risk management. As an
industry, we need to consider alternative theories on risk, and
clearly Falkenstein is on to something here. Agree with him or not,
Finding Alpha is worth a read."
—Kevin M. Blakely, President and CEO,The Risk Management Association
"Writing through the lens of an experienced practitioner,
Falkenstein digests decades of research in capital markets,
financial economics, and investment psychology that have shaped
modern investment theory. This text is an excellent companion for
portfolio managers, investment students, or anyone seeking to
better understand the relationship between risk, returns, and
—Todd Houge, PhD, CFA, The University of Iowa
How do we find alpha whenrisk does not correlate with return?
Finding Alpha is a practical guide to achieving alpha when conventional measures of risk rarely correlate with higher returns. Author Eric Falkenstein-a PhD who has also been a risk manager and portfolio manager—tells the story of alpha from its beginnings to its current reversal, where risk is now evidenced by return as opposed to vice versa.
Falkenstein begins by walking readers through the Capital Asset Pricing Model (CAPM), as well as other well-documented theories about risk and return, and explores how these theories measure up to current empirical evidence being documented by researchers and academics. He also outlines a novel approach to the issues of how benchmark risk and investor overconfidence affects expected asset returns, how to understand the nature of alpha and risk, and how to use practical applications of alpha-seeking strategies that he developed as a successful hedge fund manager.
Finding Alpha concludes by outlining some real-life applications of alpha in finance and explains how the search for alpha affects the day-to-day life of all financial professionals.
The Response: Return (Risk (Return)).
You Minimize Some Risks, Pay to Take Others.
CHAPTER 2 The Creation of the Standard Risk-Return Model.
Pillar 1: Decreasing Marginal Utility Means Risk Aversion.
Pillar 2: Diversification Means Not All Risk Is the Same.
The Arbitrage Pricing Theory (APT).
The Stochastic Discount Factor (SDF).
The Uncertainty Revival.
CAPM: A Special Case of the Stochastic Discount Factor Model.
CHAPTER 3 An Empirical Arc.
The Beginning of the End of CAPM.
Fama and French Put a Fork in the CAPM.
Saving the Standard Model.
Serial Changes to APT.
Analogy to Business Cycle Forecasting.
CHAPTER 4 Volatility, Risk, and Returns.
Total Volatility and Cross-Sectional Returns.
World Country Returns.
The Long End of the Yield Curve.
Total Volatility and Expected Equity Index Returns.
Uncertainty and Returns.
Volatility as Shorthand for Risk.
CHAPTER 5 Investors Do Not Mind Their Utility Functions.
Behavioral Violation 1: Investors Trade Too Much.
Behavioral Violation 2: Too Many Funds.
Behavioral Violation 3: Underdiversification.
Behavioral Violation 4: No Fundamental Analysis.
Behavioral Violation 5: Buy Recommendations Exclude Firms with Merely Low Risk.
Behavioral Violation 6: Agents Do Not Agree.
Behavioral Violation 7: The Home Bias.
The Rotten Core: The Utility Function.
CHAPTER 6 Is The Equity Risk Premium Zero?
Geometric versus Arithmetic Averaging.
One-time Effect of an Anomalous Post-Depression Period.
Asymmetric Tax Effects.
CHAPTER 7 Undiminished Praise of a Vacuous Theory.
CHAPTER 8 Why Relative Utility Generates Zero-Risk Premiums.
Why Relative Risk Leads to No Risk Premium.
CHAPTER 9 Why We Are Inveterate Benchmarkers.
Typical Economic Assumptions.
Virtue of Selfishness.
Why Envy Is Virtuous.
Why Economists Dislike Envy in General.
CHAPTER 10 Alpha, Risk, and Hope.
The Search for Safety.
Most Financial Risk Takers Are Foolish.
Two Types of Priced Risk.
Uncertainty in Innovation.
Why Risk Taking Hurts.
Confusion of Risk and Gambling.
Standard Alpha Contradiction.
Why We Take Risk Anyway.
Experiments, Risk, and Alpha.
CHAPTER 11 Examples of Alpha.
Finding the Right Alpha.
Arbitraging Put-Call Parity.
Convexity Trade in Futures and Swaps.
Pairs and Mean Reversion.
Long and Short Equity Hedge Funds.
CHAPTER 12 Alpha Games.
The Favor Bank.
The Alpha in Risk Management.
A Singular Risk Management Decision.
Risk Management Like Audit.
Overpaid Alpha Deceptors.
Investor Meets Alpha.
CHAPTER 13 Alpha Seeking Applications.
Minimum Volatility Portfolio.
Investing in Anomalies.
Relative Risk and Bubbles.
Capital Finding Alpha Strategies.
Search for Alpha.
CHAPTER 14 Conclusion.
Finding Alpha: The Search for Alpha When Risk and Return Break Down (US $95.00)
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